January 30, 2013

Economic Update

By George Popov '13 | january, 2013, Issue 2

Shaded areas depict periods of recession as determined by the National Bureau of Economic Research Source: Federal Reserve

Did we avoid the fiscal cliff? Interestingly enough, there is no easy answer to this question.

The American Taxpayer Relief Act addressed some of the issues, but there is a lot more work left to do. The uncertainties surrounding the debt ceiling and sequester have the ability to dampen the market sentiment. This sentiment appears to be positive, at least in the first two weeks of the year. The early earnings results came in ahead of expectations and further boosted sentiment, pushing the S&P500 up to 1,486, the highest level on the index since December 2007, the official start of the Great Recession. Despite some weakness in manufacturing, the data flow remains consistent with a slowly strengthening recovery. Retail sales in December were strong and driven mainly by gains in the discretionary categories. Additionally, home prices continue to grow and the homebuilder sentiment remains at a six-year high. These all point to strengthening feedback loops that should sustain the expansion at least in the near term.

One sign that the recovery is gaining traction is the stabilization in the demand for credit among households. After paying off about $1 trillion in debt between 2008 and 2012, the U.S. households are showing appetite for credit. Revolving credit, which is largely credit card debt, has risen in three out of the last four months and is on track for a second straight yearly increase after falling precipitously in 2009 and 2010. Nonrevolving debt has been rising strongly for more than two years, but was until recently almost entirely driven by the federal government's student loan program. The broadening confidence in a recovery could be seen in the flood of money into equity mutual funds in early January. According to Lipper, inflows into U.S. equity funds in the first full week of the year were $18.3 billion, the fourth highest total since records began more than two decades ago. One week does not make a trend, but with the S&P 500 up by more than 120% since the start of the bull market, the economy is more likely to continue to grow, even if it only a couple of percent. Abroad, we are seeing signals that the macro environment is also improving. China's GDP growth accelerated for the first time in over two years, while the OECD's global leading indicator is now rising at its fastest yearly pace since early 2011. There is still widespread weakness across the world, especially in Europe, but the aggressive global easing is delivering positives, nevertheless, they come at the risk of higher inflation in the future.

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